Market Comment: Italy: seizing the opportunity

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Last week, ABN AMRO signaled that the attractive yields of Italian government bonds were a buying opportunity for investors. But what about the political risks?

On Sunday, 4 March, Italy will elect a new parliament. Outcome predictions are difficult, however, as polls estimate that up to 45% of voters are undecided. ABN AMRO Group Economics believes that the pro-European centre-left government, consisting of Renzi’s Democratic Party and Berlusconi’s Forza Italia, has  a 40% chance of coming out on top. This coalition, however, would likely be without a majority in parliament. Other possible coalitions, e.g. centre-right or the Five Star Movement plus the Democratic Party, are given much lower probabilities of occurring. The most likely outcome is therefore a hung parliament, followed by more time spent in coalition talks to form a new government.[1]

Italy’s economy is strengthening

Italy’s political situation should not create anxiety for investors. The very supportive economic environment, both globally and in the eurozone, has dampened the negative influence of politics on economic growth. Italy has even entered a phase of higher economic growth, although still lagging other eurozone countries. An interim government under Prime Minister Paolo Gentiloni would also not be damaging. He is the most popular politician in Italy and has governed the country successfully after Matteo Renzi’s resignation in December 2016.

Political risks can be resolved

Other European countries, such as the Netherlands, have ultimately successfully resolved difficult government formations. And, on the day of the Italian election, the German Social Democrats will be announcing the result of their member voting on whether to  form another government under Angela Merkel. We expect this to be successful. The new German government will then be strongly pro-European, which further supports our positive view for Italy and other European periphery countries.

What does it mean for investors?

We think that the overall economic environment of decent economic growth and low inflation will persist for some time. Bond markets, however, have started to price-in higher inflation expectations and tighter central bank monetary policies. Government bond yields have already reached levels that touch the higher bound of the trading range. This is a clear signal to view more attractive bond yields as a buying opportunity. 

For Italian government bonds, the current risk premium seems especially attractive. Adding or expanding a position  in Italian government bonds is a way to lock-in this higher yield and to begin adding eurozone peripheral bonds back into portfolios. After the elections, we expect a tightening of the yield spread compared with core government bonds. Depending on the election results, there could  even be some spread widening, as coalition talks progress, representing an even better buying opportunity. As we believe that it is likely that Italy’s next government will be Europe-friendly, this should then produce some relief for Italian government bonds. 
Thomas Domeratzki, CIO Office, Global Investment Center

[1] For more information on the view of ABN AMRO Group Economics read, “Euro Watch, Italy heads to the polls,” 19 February 2018.